A testamentary trust is a trust created by a Will. It is generally a discretionary trust – one where the Trustee has full discretion about who benefits, and to what extent, under the trust.
Why would I use a Testamentary Trust?
Testamentary trusts can make sure the inheritance reaches the intended recipients. An independent trustee can guarantee that vulnerable beneficiaries, such as very young children or the ill, incapacitated, unstable or disabled, will be provided for. Properly drafted, trusts can also guard against the often-divisive aftermath of divorce, and ensure that in the event of remarriage, assets will be passed on to the children or grandchildren of the testator.
Testamentary trusts are also a wise precaution if the beneficiaries may face legal action or bankruptcy, such as those in professions frequently subject to litigation, or high-risk business. This form of protection is often referred to as Asset Protection.
Can a Will-Maker Restrict the Terms of a Testamentary Trust?
The terms of testamentary trusts are contained in the Will. They can include restrictions on any or all of the beneficiaries or conversely, grant them extensive control. In effect, these can enable you as the Will-maker, or testator, to rule from the grave. It is up to the testator whether they vest control in the beneficiaries or in the hands of an independent trustee. Giving control to the beneficiaries allows a greater degree of flexibility; but a managerial trustee may be better if the beneficiaries are not able to control their own finances.
How do Testamentary Trusts Work?
Testamentary trusts are drafted to mimic the operation of a discretionary trust such as a family trust: the testamentary trust will have a broad range of discretionary beneficiaries, usually the members of an extended family.
The trustee of the testamentary trust selects from the class of beneficiaries which person or people who will receive a gift of trust income or trust capital. Until the trustee elects to distribute to a beneficiary, no person has a vested interest in the assets of the trust.
Careful drafting of the testamentary trust will ensure that the beneficiary selected, who becomes a beneficiary, only has an interest in the trust to the extent that the trustee has determined. The trustee of the testamentary trust may be the executor of the deceased estate or may be some other person, who will be appointed by the Will or pursuant to a formula contained in the Will.
Often the trustee will be the person to whom the Willmaker, but for the testamentary trust, would bequeath their assets or a good part of them.
Difference of Standard Will and Testamentary Trust Will
A Standard Will, in its simplest form, is a testamentary document confirming choice of executors, beneficiaries and testamentary wishes regarding the distribution of their estate. It does not, however, offer any asset protection or tax minimisation benefits.
A Testamentary Trust Will is a type of Will that establishes a Trust or Trusts upon the death of the will maker. This kind of Will is designed to protect the will makers assets as they will belong to the beneficiaries’ Trust rather than the individual. This enables flexibility for how capital and income generated by those assets is distributed. The Trust only becomes active once the will maker is deceased. The Trustees who decide how the income is distributed can also be beneficiaries of the Trust. However, the Trustees must act in accordance with the provisions set out in the Will regarding how the Trust is to be managed.
There are two commonly utilised types of Testamentary Trusts:
Discretionary Testamentary Trusts
- where the Executor gives the beneficiary the option to take part or all of their inheritance via a Testamentary Trust. The primary beneficiary has the power to remove and appoint the trustee and they can appoint themselves to manage their inheritance inside the Trust.
Protective Testamentary Trusts
- where a Beneficiary must take their inheritance via the Trust and does not have the option to appoint or remove trustees. This is useful where the beneficiary is not in a position to responsibly manage their inheritance due to age, disability or spendthrift tendencies and is often used when parents are leaving assets to their underage children.
The potential advantages of Testamentary Trusts include:
- Asset Protection for the beneficiaries in the event of marriage or relationship breakdown (if the Trust is utilised effectively);
- Asset Protection for vulnerable beneficiaries including spendthrift beneficiaries, disabled beneficiaries or beneficiaries with a drug, alcohol or gambling problem;
- Asset Protection for “at risk” professionals or beneficiaries who may face claims from creditors or bankruptcy;
- Protection of pension entitlements;
- Income splitting advantages e.g. adult children, minors and/or other relatives on low incomes;
- Income tax advantages for children under 18 (who are taxed at adult rates instead of penalty rates outside the Testamentary Trusts environment); and
- Flexibility for the Trustee to exercise discretion about management and investment of capital and to take account of changing needs of beneficiaries.
- Tax Advantages
If a beneficiary takes their inheritance in their personal name (via a Standard Will), they will pay tax on the income generated from their inheritance at their personal marginal tax rate.
There may be significant tax advantages in taking an inheritance through a Testamentary Trust, particularly where the beneficiary has:
- a high personal marginal tax rate
- a partner on a lower income
- children and/or grandchildren who are minors or who have no, or a lower taxable income
- a tax free threshold of $18,200 (all Australian residents)
- a tax free threshold of $20,542 (Australian residents who qualify for low-income offsets).
The Trustee or Trustees can choose to distribute the income generated by the Trust in a way that minimises the tax burden of the beneficiaries. Depending upon the assets held in the Trust, a Testamentary Trust can potentially save thousands of dollars over its lifetime.
We also strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation, or needs, prior to making any investment decision.
How can we help?
If you have any questions or would like further information, please feel free to give our office on 08 9221 5522 or via email – info@camdenprofessionals.com.au , or arrange a time for a meeting so we can discuss your requirements in more detail.
General Advice Warning
The material on this page and on this website has been prepared for general information purposes only and not as specific advice to any particular person. Any advice contained on this page and on this website is General Advice and does not take into account any person’s particular investment objectives, financial situation and particular needs.
Before making an investment decision based on this advice you should consider, with or without the assistance of a securities adviser, whether it is appropriate to your particular investment needs, objectives and financial circumstances. In addition, the examples provided on this page and on this website are for illustrative purposes only.
Although every effort has been made to verify the accuracy of the information contained on this page and on this website, Camden Professionals, its officers, representatives, employees, and agents disclaim all liability [except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained in this website or any loss or damage suffered by any person directly or indirectly through relying on this information.
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